Eugen von Böhm-Bawerk’s Critique of Marx: A Quick Summary

The Austrian economist Eugen von Böhm-Bawerk’s critique of Marx can be found in his essay “Zum Abschluss des Marxschen Systems” (1896), which is available in an English translation as “Karl Marx and the Close of His System” in Böhm-Bawerk (1949: 3–120).

Paul M. Sweezy summarises Böhm-Bawerk’s case against Marx:

“After a brief introduction, he devotes two chapters to setting out Marx’s theories of value, surplus value, average rate of profit, and price of production—‘for the sake of connection,’ as he says. On the basis of this exposition he concludes that Marx had not one but two theories of value (one in Volume I of Capital and another in Volume III) in Böhm-Bawerk’s sense of the term, that is, market exchange ratios. Moreover, according to Böhm-Bawerk, these two theories lead to different results, not occasionally or exceptionally but regularly and as a matter of principle. Hence, Böhm-Bawerk ‘cannot help himself’; he is forced to the conclusion that there is a contradiction between Volume I and Volume III of Capital. He next proceeds to analyze at length—more than a third of the whole critique is devoted to this—the arguments by which, according to Böhm-Bawerk, Marx seeks to prove that the contradiction is only apparent and that the theory of Volume I is valid, after all. Having disposed of these arguments one by one, Böhm-Bawerk is at last ready to deal with the heart of the matter, ‘the error in the Marxian system,’ for it is by now clear that error there must be. Naturally, he finds that the error lies in the fact that Marx started from the old-fashioned and exploded labor theory of value instead of pushing his way through to the new and scientifically correct subjective theory of value. This error ramifies throughout the system and vitiates it from top to bottom.” (Sweezy 1949: xiii–xiv).

Böhm-Bawerk was right that the theory of value in volume 3 of Capital contradicts that in volume 1. But Böhm-Bawerk was not the first to point this out at all. In actual fact, it was the Italian economist Achille Loria (1857–1943) – himself sympathetic to Marxism – who first pointed it out in an article of 1895 (Loria 1895), which was before Böhm-Bawerk’s essay of 1896.

Those on the left who from their own reading of Marx happen to hold the same opinion as Böhm-Bawerk – that Marx’s value theory in volume 1 of Capital is radically inconsistent with the value theory in volume 3 – are not endorsing Austrian economics or anything else Böhm-Bawerk said. It is pathetic to see Marxists trying to smear their opponents by using a blatant ad hominem argument here.

In fact, one need not accept anything else in Austrian economics to agree with Böhm-Bawerk on this point. One need not even accept that subjective value is the fundamental or only cause of exchange value/price to see that Böhm-Bawerk’s criticisms have some merit.

As Böhm-Bawerk (1949: 10–11) points out, it is obvious that in volume 1 of Capital Marx refers to labour value determining real individual exchange values, as a type of regulative law of exchange value, and this can be seen in Chapter 1 and in Chapter 3 in Marx’s analysis of money.

Even though conditions of supply and demand cause prices to deviate from their pure labour values, they are brought back to them in a kind of equilibrium process:

“The production of commodities must be fully developed before the scientific conviction emerges, from experience itself, that all the different kinds of private labour (which are carried on independently of each other; and yet, as spontaneously developed branches of the social division of labour, are in a situation of all-round dependence on each other) are continually being reduced to the quantitative proportions in which society requires them. The reason for this reduction is that in the midst of the accidental and ever-fluctuating exchange relations between the products, the labour-time socially necessary to produce them asserts itself as a regulative law of nature. In the same way, the law of gravity asserts itself when a person’s house collapses on top of him. The determination of the magnitude of value by labour-time is therefore a secret hidden under the apparent movements in the relative values of commodities.” (Marx 1982: 168).

“It is not money that renders commodities commensurable. Just the contrary. It is because all commodities, as values, are realised human labour, and therefore commensurable, that their values can be measured by one and the same special commodity, and the latter be converted into the common measure of their values, i.e., into money. Money as a measure of value, is the phenomenal form that must of necessity be assumed by that measure of value which is immanent in commodities, labour-time.” (Marx 1906: 106).

When Marx, for example, says that it is possible to accurately measure the value of skilled labour by looking at the exchange values of products of skilled labour as against products of unskilled labour (Marx 1906: 51–52), this makes no sense unless Marx really believes that commodities tend to exchange at pure labour values.

Furthermore, for Marx money must by necessity be a produced commodity with a labour value in order to even function as money, and commodity money like gold or silver, when it is initially brought to market, is exchanged with other commodities with an equal socially necessary labour time value as a barter transaction (Marx 1906: 122). And Marx thought that prices are determined by (at the least) (1) the long-run labour value of gold as determined by the abstract socially necessary labour time required for gold’s production and (2) as this labour value of gold relates in exchange to the labour value of other commodities (Marx 1906: 108) (on this, see here). Of course, these ideas, if taken seriously, require that the actual exchange value of gold as money against other commodities gravitates around the long-run value of the abstract socially necessary labour time needed to produce gold.

But in volume 3 Marx abandons the idea that individual exchange values tend to equal abstract socially-necessary labour time in his attempts to solve the transformation problem and in his acceptance that Classical prices of production are the long-run anchors for prices:

“To speak plainly his solution [sc. to the transformation problem] is obtained at the cost of the assumption from which Marx has hitherto started, that commodities exchange according to their values. This assumption Marx now simply drops.” (Böhm-Bawerk 1949: 21).

“And the actual exchange relation of the separate commodities is no longer determined by their values but by their prices of production; or as Marx likes to put it ‘the values change into prices of production’ (III, 231). Value and price of production are only exceptionally and accidentally coincident, namely, in those commodities which are produced by the aid of a capital, the organic composition of which chances to coincide exactly with the average composition of the whole social capital. In all other cases value and production price necessarily and in principle part company.” (Böhm-Bawerk 1949: 24).

But that radically contradicts what Marx said in volume 1 of Capital, and Böhm-Bawerk points to the paradox:

“‘Either products do actually exchange in the long run in proportion to the labor attaching to them—in which case an equalization of the gains of capital is impossible; or there is an equalization of the gains of capital—in which case it is impossible that products should continue to exchange in proportion to the labor attaching to them.’” (Böhm-Bawerk 1949: 28).

“I do not think that any one who examines the matter impartially and soberly can remain long in doubt. In the first volume it was maintained, with the greatest emphasis, that all value is based on labor and labor alone, and that values of commodities were in proportion to the working time necessary for their production. These propositions were deduced and distilled directly and exclusively from the exchange relations of commodities in which they were ‘immanent.’ We were directed ‘to start from the exchange value, and exchange relation of commodities, in order to come upon the track of the value concealed in them’ (I, 55). The value was declared to be ‘the common factor which appears in the exchange relation of commodities’ (I, 45). We were told, in the form and with the emphasis of a stringent syllogistic conclusion, allowing of no exception, that to set down two commodities as equivalents in exchange implied that ‘a common factor of the same magnitude’ existed in both, to which each of the two ‘must be reducible’ (I, 43). Apart, therefore, from temporary and occasional variations which ‘appear to be a breach of the law of the exchange of commodities’ (I, 177), commodities which embody the same amount of labor must on principle, in the long run, exchange for each other. And now in the third volume we are told briefly and dryly that what, according to the teaching of the first volume, must be, is not and never can be; that individual commodities do and must exchange with each other in a proportion different from that of the labor incorporated in them, and this not accidentally and temporarily, but of necessity and permanently.

I cannot help myself; I see here no explanation and reconciliation of a contradiction, but the bare contradiction itself. Marx’s third volume contradicts the first. The theory of the average rate of profit and of the prices of production cannot be reconciled with the theory of value. This is the impression which must, I believe, be received by every logical thinker.” (Böhm-Bawerk 1949: 29–30).

Many other critics of Marx have argued the same thing (Shove 1944: 48–49; Robinson 1966: 10, 14).

And, as Böhm-Bawerk noted, Marx attempted to solve this severe contradiction by certain arguments.

The most important of them was that, when the profit rate is equalised and stands at an average percentage of profit, prices above values and prices below values cancel out so that in the aggregate prices equal value (Böhm-Bawerk 1949: 32). But, given that labour value cannot even be properly defended in the first place, this is an absurd and empirically empty idea lacking any explanatory power.

Böhm-Bawerk knew this fundamental problem well: economists have no reason to accept the basic labour theory of value in the first place (Böhm-Bawerk 1949: 64–66).

That idea that exchange value fundamentally depends on quantities of labour expended in production of commodities is not “self-evident” (Böhm-Bawerk 1949: 65). That is, it is not some empirical proposition confirmed by convincing and clear evidence:

“Now it is certain that the exchange values, that is to say the prices of the commodities as well as the quantities of labor which are necessary for their reproduction, are real, external quantities, which on the whole it is quite possible to determine empirically. Obviously, therefore, Marx ought to have turned to experience for the proof of a proposition the correctness or incorrectness of which must be manifested in the facts of experience; or in other words, he should have given a purely empirical proof in support of a proposition adapted to a purely empirical proof. This, however, Marx does not do. And one cannot even say that he heedlessly passes by this possible and certainly proper source of knowledge and conviction. The reasoning of the third volume proves that he was quite aware of the nature of the empirical facts, and that they were opposed to his proposition. He knew that the prices of commodities were not in proportion to the amount of incorporated labor, but to the total cost of production, which comprises other elements besides. He did not therefore accidentally overlook this, the most natural proof of his proposition, but turned away from it with the full consciousness that upon this road no issue favourable to his theory could be obtained.” (Böhm-Bawerk 1949: 66).

There is no convincing empirical evidence that the labour theory of value is correct, and Marxists often reduce it to a mere tautologous analytic statement that is empirically-empty anyway.

The remaining parts of Böhm-Bawerk’s essay mostly focus on diminishing marginal utility theory as an alternative theory of value, but one simply does not need to accept this to see the merits of Böhm-Bawerk’s critique as sketched above.

BIBLIOGRAPHY
Böhm-Bawerk, Eugen von. 1949. “Karl Marx and the Close of His System,” in Paul. M. Sweezy (ed.), Karl Marx and the Close of His System and Böhm-Bawerk’s Criticism of Marx. August M. Kelley, New York. 3–120.

Loria, Achille. 1895. “L’opera postuma di Carlo Marx,” Nuova Antologia di Scienze 55.3 (February): 460–496.

Loria, Achille. 1920. Karl Marx. (trans. Eden and Cedar Paul), George Allen and Unwin Ltd., London.

Marx, Karl. 1906. Capital. A Critique of Political Economy (vol. 1; trans. Samuel Moore and Edward Aveling from 3rd German edn.; rev. from 4th German edn. by Ernest Untermann). The Modern Library, New York.

Marx, Karl. 1982. Capital. Volume One. A Critique of Political Economy (trans. Ben Fowkes). Penguin Books, Harmondsworth, England.

Robinson, Joan. 1966. An Essay on Marxian Economics (2nd edn.). Macmillan, London.

Shove, Gerald F. 1944. “Mrs. Robinson on Marxian Economics,” The Economic Journal 54.213: 47–61.

Sweezy, Paul. M. 1949. “Editor’s Introduction,” in Paul. M. Sweezy (ed.), Karl Marx and the Close of His System and Böhm-Bawerk’s Criticism of Marx. August M. Kelley, New York. v–xxx.

Foucault’s Discipline and Punish: A Summary and Critique

In 1975, Foucault published the following book:

Foucault, Michel. 1975. Surveiller et punir. Gallimard, Paris. = Foucault, Michel. 1977. Discipline and Punish (trans. Alan Sheridan). Pantheon, New York.

In Discipline and Punish Foucault examines the origin of the modern prison.

Foucault divides the time he deals with into two periods as follows:

(1) the age of torture during the Ancien Regime which ended in the late 18th century;

(2) the “carceral” age from the late 18th century onwards in which torture and capital punishment were progressively abolished and the modern penal system (with prisons) was born and became dominant.

The Enlightenment gave birth to the ideas that brought about the transition from the age of torture to the carceral age where torture was to be abolished and punishments conducted not in revenge but in a hierarchy proportionate to the crimes committed (Merquior 1991: 89), and punishment shifted from the body of the criminal to the mind or aspects of social control.

However, for Foucault, and despite the humanitarianism that underlay the reforms, there was a new degree of social control worse and more oppressive than in the pre-modern age (Merquior 1991: 90). Worse still, for Foucault, Enlightenment utopian thinking was essentially a type of totalitarianism (Merquior 1991: 90), and Jeremy Bentham’s institutional model of the Panopticon as applied to prisons becomes a metaphor for the modern carceral society (Merquior 1991: 91).

The “Panopticon” is thus the model and epitome of the emerging “bourgeois” surveillance and disciplinary society in schools, military barracks, armies, factories, hospitals and prisons (Merquior 1991: 92), so that there is a whole “carceral” system that characterises modern society where people are coerced, and the school and factory are the mirror of the prison. According to Foucault, the modern penitentiary system supposedly just creates recidivism and manufactures criminals.

One can see obvious intellectual sources for the theory presented in Discipline and Punish. Foucault’s obsession with identifying his “carceral” system with the rise of “bourgeois” society is a blatant hangover from his Marxist days; his theory is very much a Kulturkritic in the spirit of the Frankfurt school of Adorno and Marcuse; and his view of the Enlightenment is one-sided and unfair (Merquior 1991: 98–99), and harks back to counter-Enlightenment thought. Merquior (1991: 100–101), in an interesting assessment, sees Foucault’s critique as a hybrid of Western Marxism and neo-Nietzschean philosophy.

The troubles with Foucault’s analysis run fairly deep. Foucault’s own research applies mostly to France, not other Western countries (Merquior 1991: 96–97). Is the carceral society supposed to be a general theory of Western civilisation?

Historians have pointed out that elements of the Ancien Regime persisted well into the 19th century in numerous countries, and many of the alleged aspects of the bourgeois “carceral” society – supposedly symptomatic of bourgeois schools, military systems, etc. – seem better explained as the hangovers from the older system (Merquior 1991: 103). Curiously even Foucault admits this. To take a concrete example, intensely harsh systems of surveillance and discipline have been the core of military training in many ages, and were particularly so in the Ancien Regime. Even important aspects of what Foucault would call the “bourgeois” regimentation and disciplining of society and of the body seem to come right out of traditional Christianity (Merquior 1991: 103), not the Enlightenment.

If anything, there was in education a liberating and humanitarian spirit to the educational ideas of the Enlightenment compared to the harsh, disciplinarian style of the Ancien Regime, so that even if one were to accept Foucault’s view of the “bourgeois” school as the mirror of the prison this seems grossly unfair to the Enlightenment (Merquior 1991: 103–104). In fact, in the aftermath of the defeat of Napoleon, there was a very powerful conservative backlash against liberalism and Enlightenment thinking in Europe, which persisted in some countries well into the 19th century and seems far more suited to the “discipline and punish” model of society that Foucault imagines.

Other unfortunate errors mar Foucault’s theory. Foucault’s claims about the timing of the changes in the Western penal system are wrong. The evidence shows that the number of crimes punished by the death penalty actually increased right down to the early 19th century (Windschuttle 1998: 22–23), not fell, and corporal punishment was regularly used for most of the 19th century. In Britain, there was an increased use of transportation to penal colonies in Australia as a regular punishment for crime and in the case of Britain this only ended in 1868 (Windschuttle 1994: 149).

Windschuttle (1998: 23) argues that it was only from the 1880s, not the 1780s as in Foucault, that execution and corporal punishment became rare events and prison became the standard punishment for virtually all offenses. Even then, the reforms came from the rise of more humane ideas within democratic, liberal political systems – not simply from Enlightenment thinking (Windschuttle 1998: 26–28).

Even the original Enlightenment penal reformers’ views sit uncomfortably with Foucault’s interpretation of them. Merquior (1991: 104–105) points out that one of the most influential penal reformers of the Enlightenment whose influence continued well into the 19th century was Cesare Beccaria (1738–1794), who was clearly an egalitarian and libertarian reformer, not an advocate of some universal surveillance society bent on regimenting all aspects of life and human bodies.

Finally, we have the omnipresent problem in Foucault’s work: if we take seriously his idea that there are no objective truths, then why would anyone take seriously as objectively true any explanation Foucault has to offer about the emergence of the modern penal system?

Links
Gutting, Gary. 2003 (rev. 2013). “Michel Foucault,” Stanford Encyclopedia of Philosophy
http://plato.stanford.edu/entries/foucault/

Kelly, Mark. “Michel Foucault (1926–1984),” Internet Encyclopedia of Philosophy
http://www.iep.utm.edu/foucault/

“Michel Foucault,” Wikipedia
http://en.wikipedia.org/wiki/Michel_Foucault

BIBLIOGRAPHY
Brown, Robert. 1978. “The Idea of Imprisonment,” Times Literary Supplement no. 3976, 16 June 1978, p. 658.

Merquior, José Guilherme. 1991. Foucault (2nd edn.). Fontana, London.

Scull, Andrew. 2007. “Scholarship of Fools,” Times Literary Supplement no. 5425, 23 March 2007, pp. 3–4.

Windschuttle, K. 1998. “Foucault as Historian,” in Robert Nola (ed.). Foucault. F. Cass, London and Portland, Or. 5–35.

Windschuttle, Keith. 1994. The Killing of History: How a Discipline is being murdered by Literary Critics and Social Theorists. Macleay Press, Sydney.

Steve Keen’s “A Marx for Post Keynesians”

Steve Keen’s paper “A Marx for Post Keynesians” can be found here:

Steve Keen, “A Marx for Post Keynesians,”
http://keenomics.s3.amazonaws.com/debtdeflation_media/papers/Amfpk.pdf

I have to admit I’ve only skimmed this before and some time ago, but I will look at its main points in what follows.

Keen argues that there are actually “two sets of axioms developed by Marx, but lost to Marxian political economy by its slavish adherence to the Labor Theory of Value” (Keen, “A Marx for Post Keynesians,” p. 1). One of these sets of axioms might be methodologically useful in Post Keynesian economics.

What Keen argues is this:

“Marx employed two distinct sets of axioms in his thinking. One set, which I will call Marx’s Labor Axioms, has been treated as Marxism’sole intellectual foundation since Hilferding’s 1904 rejoinder to Böhm-Bawerk. The other set, which I will call Marx's Commodity Axioms, was regarded by Marx as logically prior and superior to his Labor Axioms, though he believed--erroneously--that the two sets were consistent.” (Keen, “A Marx for Post Keynesians,” p. 4).

According to Keen, the Labour Axioms in Marx are as follows:

“1) Value is ‘socially necessary abstract labor-time’;
2) Under capitalism, when markets are in equilibrium, commodities exchange in proportion to the amount of value they contain;
3) Under capitalism, the ability to perform work, labor-power, has itself become a commodity;
4) In production, labor transfers its value directly to the product, while the commodities used up in production transfer their value indirectly;
5) Labor is unique because of the difference between the commodity sold by workers, labor-power, and the commodity consumed in production, labor itself.”
(Keen, “A Marx for Post Keynesians,” pp. 4–5).

Ultimately, this set of axioms is not valid, argues Keen, and there are other problems with Marx’s analysis, such as, for example, that his treatment of money in volume 1 of Capital is close to an orthodox quantity theory of money (Keen, “A Marx for Post Keynesians,” p. 12).

By contrast, Keen sees Marx’s “Commodity Axioms” as follows:

“1) The commodity is the essential unity in capitalism;
2) Commodities have two aspects: use-value and exchange-value;
3) Under capitalism, use-value and exchange-value are incommensurable, so that the use-value of a commodity plays no role in determining its exchange-value;
4) Use-value is an objective property of commodities, assessed however from the point of view of the consumer;
5) The exchange-value of a commodity is the exchange-value of the commodities used up in its production;
6) Under capitalism, the ability to perform work, labor-power, has itself become a commodity;
7) Capitalism has two main circuits, the Circuit of Commodity Capital (C--M--C), where the objective is the consumption of use-values, and of the Circuit of Money Capital (M--C--M+), where the objective is the production of surplus value.” (Keen, “A Marx for Post Keynesians,” pp. 5–6).

These axioms, amongst other things, lead to a “distinctly monetary view of capitalism which emanates from them” (Keen, “A Marx for Post Keynesians,” p. 9), which is compatible with Post Keynesian economics.

Keen analyses these commodity axioms and comes to the conclusion that

“The Commodity Axioms thus lead to the conclusion that surplus can be generated by all inputs to production, thus supporting the Neo-Ricardian and Post Keynesian approaches to production, and contradicting conventional Labor Theory of Value Marxism’s insistence that labor is the only such source. Marx’s attempt to avoid this conclusion in Capital was a logical failure, which nonetheless succeeded in convincing a century of Marxists (and their critics), chiefly by obscuring his Commodity Axioms, to leave only the Labor Axioms as his apparent legacy to economics (the historiography of this is covered in Keen 1993a and 1993b). Twentieth century Marxism thus developed--and foundered--on the basis of Marx’s Labor Axioms.” (Keen, “A Marx for Post Keynesians,” p. 9).

For example, by means of his labour axioms, Marx sees wages as determined by real phenomena: Marx’s view that the wage is on average the value of labour power which reduces to the subsistence wage is at variance with the Post Keynesian view that wages are fundamentally a monetary phenomenon determined by institutional factors (Keen, “A Marx for Post Keynesians,” p. 10). But Marx’s commodity axioms lead to the Post Keynesian view, unlike the labour axioms. Moreover, ultimately labour cannot be treated just as a commodity like any other (Keen, “A Marx for Post Keynesians,” p. 10).

Another useful insight that Marx had in his “Commodity Axioms” was that in capitalism the capitalists want more money as the ultimate aim of production, so that there is a “Circuit of Capital” in which money is used to buy factor input commodities and then these are used to create an output commodity which is then sold to obtain more money (which can be expressed as M – C – M). This insight was “about the only aspect of Marx’s thought for which Keynes expressed admiration” (Keen, “A Marx for Post Keynesians,” p. 7, n. 10).

I am not so sure about the value of these “Commodity Axioms.” Axiom (5) seems untrue to me, and would be better stated:

(5) in cost-based, mark-up price markets, the exchange-value of a commodity is based on total costs, but not identical to it.

Keen himself seems to admit that axiom 6 is unsatisfactory and proposes this axiom:

“1) Labor-power is both a commodity and a non-commodity, giving rise to a dialectic of labor, which determines the wage.” Keen, “A Marx for Post Keynesians,” p. 7, n. 11).

So, all in all, the case for basing Post Keynesian economics on the original “Commodity Axioms” seems problematic.

BIBLIOGRAPHY
Steve Keen, “A Marx for Post Keynesians,”
http://keenomics.s3.amazonaws.com/debtdeflation_media/papers/Amfpk.pdf

Foucault’s The Archaeology of Knowledge: A Quick Summary

In 1969, Foucault published the following book:

Foucault, Michel. 1969. L’archéologie du savoir. Gallimard, Paris. = Foucault, Michel. 1972. The Archaeology of Knowledge (trans. Allan Sheridan). Harper and Row, New York.

It seems to mark a new methodological perspective in his work (Merquior 1991: 77) and the point when Foucault was turning to Poststructuralism.

The Archaeology of Knowledge is an clear attempt to state and expound the fundamental “archaeological” method Foucault used in The Order of Things, History of Madness and The Birth of the Clinic. Foucault came in his later works to have a new method called “genealogy” (supplementing “archaeology”), which was supposed to show how systems of thought unearthed by “archaeology” were merely contingent accidents of history.

The emphasis in The Archaeology of Knowledge now seems to be on discourses or discursive formations (practices or statements that reign in a particular time), and the influence of Friedrich Nietzsche’s “genealogical” philosophy has become very important (Merquior 1991: 77).

Another new concept in The Archaeology of Knowledge is the archive, but one will be hard pressed to actually understand what Foucault means by this.

Let Foucault – in that wonderfully lucid prose for which he was famous – explain it to you:

“Between the language (langue) that defines the system of constructing possible sentences, and the corpus that passively collects the words that are spoken, the archive defines a particular level: that of a practice that causes a multiplicity of statements to emerge as so many regular events, as so many things to be dealt with and manipulated. It does not have the weight of tradition; and it does not constitute the library of all libraries, outside time and place; nor is it the welcoming oblivion that opens up to all new speech the operational field of its freedom; between tradition and oblivion, it reveals the rules of a practice that enables statements both to survive and to undergo regular modification. It is the general system of the formation and transformation of statements.

It is obvious that the archive of a society, a culture, or a civilization cannot be described exhaustively; or even, no doubt, the archive of a whole period. On the other hand, it is not possible for us to describe our own archive, since it is from within these rules that we speak, since it is that which gives to what we can say – and to itself, the object of our discourse – its modes of appearance, its forms of existence and coexistence, its system of accumulation, historicity, and disappearance. The archive cannot be described in its totality; and in its presence it is unavoidable. It emerges in fragments, regions, and levels, more fully, no doubt, and with greater sharpness, the greater the time that separates us from it: at most, were it not for the rarity of the documents, the greater chronological distance would be necessary to analyse it.” (Foucault 1972: 130).

Was that clear? Well, yes: about as clear as mud.

Here was a man trying to explain a crucial concept of his work, but does very little except reveal to everyone watching that the pretentious French emperor has no clothes.

The archive is not, apparently, our faculty of language. But, according to Foucault, the archive is “the general system of the formation and transformation of statements” (Foucault 1972: 130). But transformation of statements into what? Even more shockingly, we cannot even “describe our own archive”! So how do we know one even exists?

Merquior, who tries hard to see through the fog of Foucault’s gibberish, thought that the archive is a system for generating social meaning (Merquior 1991: 81), whatever that means. Foucault also regarded the archive as the historical a priori (Merquior 1991: 81), so whatever it represents it seems to be analogous to the epistemes of his previous work The Order of Things.

It seems that Foucault was soon arguing that “discourses” in any society were the product of control and rules and access to knowledge (Merquior 1991: 84). The stage was now set for Foucault’s idea that power creates knowledge.

Further attempts to make sense of The Archaeology of Knowledge seem like a complete waste of time to me – or at least I think there are probably much more productive things you could be doing with your waking hours.

Gilles Deleuze – another grand Poststructuralist charlatan – apparently drew the lesson from Foucault’s Archaeology of Knowledge that one should make no distinction between science and poetry! (Merquior 1991: 84). If anyone believes this outrageous idiocy, then by all means act on Deleuze’s sage advice and seek the services of a poet instead of using science-based medicine when you get sick! I am sure that will fix you right up...

Links
Gutting, Gary. 2003 (rev. 2013). “Michel Foucault,” Stanford Encyclopedia of Philosophy
http://plato.stanford.edu/entries/foucault/

Kelly, Mark. “Michel Foucault (1926–1984),” Internet Encyclopedia of Philosophy
http://www.iep.utm.edu/foucault/

“Michel Foucault,” Wikipedia
http://en.wikipedia.org/wiki/Michel_Foucault

BIBLIOGRAPHY
Merquior, José Guilherme. 1991. Foucault (2nd edn.). Fontana, London.

Foucault, Michel. 1972. The Archaeology of Knowledge and the Discourse on Language (trans. A. M. Sheridan Smith). Pantheon Books, New York.

Foucault’s The Order of Things: A Summary and Critique

This was one of Foucault’s major works:

Foucault, Michel. 1966. Les mots et les choses [Words and Things]. Gallimard, Paris. = Foucault, Michel. 1973. The Order of Things: An Archaeology of the Human Sciences (trans. Alan Sheridan). Vintage, New York. 387 p.; and Foucault, Michel. 2002. The Order of Things: An Archaeology of the Human Sciences. Routledge, London. 422 p.

Many would argue that this book strongly uses Structuralist ideas, although at the same time pointing to the limits of Structuralism. Indeed, many in France regarded the work as a tour de
force of Structuralism when it was published (Flynn 2005: 32).

In The Order of Things, Foucault is concerned with epistemes: an episteme is a set of ordered but unconscious ideas that are foundational in determining what is regarded as accepted knowledge in particular periods and times. This was also called the “historical a priori” by Foucault (Flynn 2005: 31; Merquior 1991: 36). But the episteme is not a general body of known knowledge or natural science. An episteme is a kind of unspoken and unconscious stratum underlying and being the precondition for accepted knowledge in each historical period, so that Foucault thought that to unearth the episteme of a period one engages in a metaphorical “archaeology” (Merquior 1991: 36).

Each episteme from one period to the next is supposed to be discontinuous and incommensurable in the sense of being radically different (Merquior 1991: 37), and there is only one underlying episteme for each historical period:

“In any given culture and at any given moment, there is always only one episteme that defines the conditions of possibility of all knowledge, whether expressed in a theory or silently invested in a practice.” (Foucault 1970: 178).

Some examples of historical epistemes as identified by Foucault are as follows:

(1) the pre-Classical period (the later Middle ages and Renaissance up to the mid-17th century), in which people thought in terms of similitudes, resemblances and antipathies (Merquior 1991: 45);

(2) the “Classical” period (the mid-17th to 18th centuries), in which the prevailing episteme stressed representation, mathesis (a science of order and measurement), and taxinomia (science of classification) (Merquior 1991: 46);

(3) the “Modern” period (the 19th century to about the 1950s), in which deep, dynamic historical explanations became important (Merquior 1991: 51);

(4) the contemporary age (from the 1950s onwards) (Merquior 1991: 37, 39).

As an aside, strangely missing in Foucault’s scheme is the ancient Graeco-Roman world, but let us not dwell on this point.

When one episteme is replaced by another, this process is by some irrational and cultural revolution akin to religious conversion or mass psychology, not by rational argument or evidence (Merquior 1991: 37).

As Foucault’s fierce critic José Merquior argues, all these central ideas of Foucault are highly questionable.

Foucault’s insistence that each episteme represents a sharp break with the previous one and a fundamental discontinuity does not withstand much scrutiny (Merquior 1991: 58). Merquior sees deep problems in Foucault’s attempt to classify Western intellectual history into his four periods with underlying epistemes, and identifies devastating problems as follows:

(1) the transepistemic objection: some fundamental ideas and epistemic principles which span more than one era (Merquior 1991: 62–65);

(2) “epistemic lag” objection: when significant ideas and theories from a previous episteme persist into the next period (Merquior 1991: 65);

(3) the return of earlier ideas or systems of thought: when ideas or theories supposedly overthrown by a new episteme actually reappear and are influential (Merquior 1991: 65–67);

(4) heterogeneous epistemological ideas within each of Foucault’s specific periods: often we find Foucault’s characterisation of the reigning ideas of each period is shoddy and simplistic and does not do justice to the actual state of affairs in that era (Merquior 1991: 67–69);

(5) instances when some fundamental theory supposedly characterising each episteme collapsed well before the end of its period (Merquior 1991: 69).

To give some examples, the ideas supposedly at the heart of the Classical era were already clearly in evidence in the pre-Classical period, especially in the realm of the emerging science of cosmology (Merquior 1991: 58). Taxonomy was already a fundamental part of the Aristotelian philosophy that was very influential in the Middle Ages (Merquior 1991: 59).

Within alleged periods where one episteme supposedly ruled, one can find a great degree of pluralism in which it is difficult to see how some monolithic underlying episteme could really have existed (Merquior 1991: 62–68).

And finally we get to a really devastating problem with Foucault’s periods with underlying epistemes: Foucault was not concerned with the question of whether ideas in epistemes or in general knowledge overarching them could be justified as rational or objectively true. He had no interest in The Order of Things in whether there was a development of growing ideas that can rightly be regarded as objectively true (Merquior 1991: 71). But in any history of human knowledge or the epistemological ideas underlying the sciences this is a fundamentally important question.

By contrast, in Foucault’s The Order of Things there is a lazy and unproven assumption that what Foucault called the human sciences (namely, the biological, psychological, and social sciences) and the principles of any given episteme cannot get to objective truth or be rationally defended as against other epistemic principles or ideas.

If you are engaged in the history of knowledge as Foucault was, but are not willing to seriously address the question whether empirical truths and foundational epistemic principles can be rationally defended or are objectively true, then the whole project has missed the point.

Links
Gutting, Gary. 2003 (rev. 2013). “Michel Foucault,” Stanford Encyclopedia of Philosophy
http://plato.stanford.edu/entries/foucault/

Kelly, Mark. “Michel Foucault (1926–1984),” Internet Encyclopedia of Philosophy
http://www.iep.utm.edu/foucault/

“Michel Foucault,” Wikipedia
http://en.wikipedia.org/wiki/Michel_Foucault

BIBLIOGRAPHY
Merquior, José Guilherme. 1991. Foucault (2nd edn.). Fontana, London.

Flynn, Thomas. 2005. “Foucault’s Mapping of History,” Gary Gutting (ed.), The Cambridge Companion to Foucault (2nd edn.). Cambridge University Press, Cambridge, U.K. and New York. 29–48.

Foucault, Michel. 1970. The Order of Things: An Archaeology of the Human Sciences. Vintage Books, New York.

Hayek’s Prices and Production (1935), Lecture IV: A Summary

I summarise below Lecture IV of Hayek’s Prices and Production (2nd edn.; 1935), the classic work where Hayek developed his version of the Austrian business cycle theory (ABCT). I use the second, revised edition of 1935 (the first edition was published in 1931).

In Lecture IV, Hayek considers the arguments for and against an elastic money supply. We must remember that Hayek’s main concern was to make money “neutral” with respect to the structure of production.

Hayek comes out very strongly against money supply expansion as production increases, and advocates deflation as a natural state of affairs:

“If the considerations brought forward in the last lecture are at all correct, it would appear that the reasons commonly advanced as a proof that the quantity of the circulating medium should vary as production increases or decreases are entirely unfounded. It would appear rather that the fall of prices proportionate to the increase in productivity, which necessarily follows when, the amount of money remaining the same, production increases, is not only entirely harmless, but is in fact the only means of avoiding misdirections of production.” (Hayek 1935: 105).

Hayek rejects the idea that money supply should change in relation to the volume of production (Hayek 1935: 105–108), though seems to suggest that meeting the demand for high-powered money in times of crisis, as long as it does not increase the total quantity of money, might be acceptable (Hayek 1935: 112–113):

“The second source of the prevalent belief that, in order to prevent dislocation, the quantity of the circulating medium must adapt itself to the changing needs of trade arises from a confusion between the demand for particular kinds of currency and the demand for money in general. This occurs especially in connection with the so-called seasonal variations of the demand for currency which in fact arises because, at certain times of the year, a larger proportion of the total quantity of the circulating medium is required in cash than at other times. The regularly recurring increase of the ‘demand for money’ at quarter days, for instance, which has played so great a role in discussions of central bank policy since attention was first drawn to it by the evidence of J. Horsley Palmer and J. W. Gilbart before the parliamentary committees of 1832 and 1841, is mainly a demand to exchange money held in the form of bank deposits into bank notes or coin. The same thing is true in regard to the ‘increased demand for money’ in the last stages of a boom and during a crisis. When, towards the end of a boom period, wages and retail prices rise, notes and coin will be used in proportionately greater amounts, and entrepreneurs will be compelled to draw a larger proportion of their bank deposits in cash than they used to do before. And when, in a serious crisis, confidence is shaken, and people resort to hoarding, this again only means that they will want to keep a part of their liquid resources in cash which they used to hold in bank money, etc. All this does not necessarily imply a change in the total quantity of the circulating medium, if only we make this concept comprehensive enough to comprise everything which serves as money, even if it does so only temporarily.” (Hayek 1935: 112–113).

It is interesting to see that Hayek also recognises that the private sector often creates credit money itself and that this will be convertible into high-powered money too:

“(5) But at this point we must take account of a new difficulty which makes this concept of the total quantity of the circulating medium somewhat vague, and which makes the possibility of ever actually fixing its magnitude highly questionable. There can be no doubt that besides the regular types of the circulating medium, such as coin, bank notes and bank deposits, which are generally recognised to be money or currency, and the quantity of which is regulated by some central authority or can at least be imagined to be so regulated, there exist still other forms of media of exchange which occasionally or permanently do the service of money. Now while for certain practical purposes we are accustomed to distinguish these forms of media of exchange from money proper as being mere substitutes for money, it is clear that, ceteris paribus, any increase or decrease of these money substitutes will have exactly the same effects as an increase or decrease of the quantity of money proper, and should therefore, for the purposes of theoretical analysis, be counted as money.

In particular, it is necessary to take account of certain forms of credit not connected with banks which help, as is commonly said, to economise money, or to do the work for which, if they did not exist, money in the narrower sense of the word would be required. The criterion by which we may distinguish these circulating credits from other forms of credit which do not act as substitutes for money is that they give to somebody the means of purchasing goods without at the same time diminishing the money spending power of somebody else. This is most obviously the case when the creditor receives a bill of exchange which he may pass on in payment for other goods. It applies also to a number of other forms of commercial credit, as, for example, when book credit is simultaneously introduced in a number of successive stages of production in the place of cash payments, and so on. The characteristic peculiarity of these forms of credit is that they spring up without being subject to any central control, but once they have come into existence their convertibility into other forms of money must be possible if a collapse of credit is to be avoided. But it is important not to overlook the fact that these forms of credits owe their existence largely to the expectation that it will be possible to exchange them at the banks against other forms of money when necessary, and that, accordingly, they might never come into existence if people did not expect that the banks would in the future extend credit against them. The existence of this kind of demand for more money, too, is therefore no proof that the quantity of the circulating medium must fluctuate with the variations in the volume of production. It is only a proof that once additional money has come into existence in some form or other, convertibility into other forms must be possible.” (Hayek 1935: 113–115).

It is undoubtedly true that negotiable bills of exchange, negotiable promissory notes, negotiable cheques, and other private sector, monetised IOUs can expand the money supply, but Hayek never even considers that this might be sufficient to drive one of his Austrian business cycles – a serious flaw in his analysis. For the simple reason is that these forms of credit money need not be backed by prior “saving” and their expansion, if the “discount” on such bills falls below the “natural rate,” would increase the demand for factor inputs and perhaps even higher order capital investments.

Some few instances where an increase in the money supply are warranted are discussed by Hayek too (Hayek 1935: 120–124). If one firm splits into two firms and the need for money to purchase factor inputs thereby increases, then an increase in money supply may be warranted (Hayek 1935: 120–121).

Also, if there is a change in velocity of circulation, then the amount of money in circulation may need to be changed (Hayek 1935: 123–124).

However, Hayek immediately qualifies these concessions:

“(10) Even now our difficulties are not at an end. For, in order to eliminate all monetary influences on the formation of prices and the structure of production, it would not be sufficient merely quantitatively to adapt the supply of money to these changes in demand, it would be necessary also to see that it came into the hands of those who actually require it, i.e., to that part of the system where that change in business organisation or the habits of payment had taken place. It is conceivable that this could be managed in the case of an increase of demand. It is clear that it would be still more difficult in the case of a reduction. But quite apart from this particular difficulty which, from the point of view of pure theory, may not prove insuperable, it should be clear that only to satisfy the legitimate demand for money in this sense, and otherwise to leave the amount of the circulation unchanged, can never be a practical maxim of currency policy. No doubt the statement as it stands only provides another, and probably clearer, formulation of the old distinction between the demand for additional money as money which is justifiable, and the demand for additional money as capital which is not justifiable. But the difficulty of translating it into the language of practice still remains. The ‘natural’ or equilibrium rate of interest which would exclude all demands for capital which exceed the real supply capital, is incapable of ascertainment, and, even if it were not, it would not be possible, in times of optimism, to prevent the growth of circulatory credit outside the banks.

Hence the only practical maxim for monetary policy to be derived from our considerations is probably the negative one that the simple fact of an increase of production and trade forms no justification for an expansion of credit, and that—save in an acute crisis—bankers need not be afraid to harm production by overcaution. Under existing conditions, to go beyond this is out of the question. In any case, it could be attempted only by a central monetary authority for the whole world: action on the part of a single country would be doomed to disaster. It is probably an illusion to suppose that we shall ever be able entirely to eliminate industrial fluctuations by means of monetary policy. The most we may hope for is that the growing information of the public may make it easier for central banks both to follow a cautious policy during the upward swing of the cycle, and so to mitigate the following depression, and to resist the well-meaning but dangerous proposals to fight depression by ‘a little inflation.’” (Hayek 1935: 124–125).

In other words, even the few exceptions where changes in the money supply are theoretically warranted are practically difficult or impossible to actually address by central banks.

Finally, Hayek thought the prolonged economic problems of the 1930s were being caused by government interventions, in addition to the monetary disturbances that form part of his ABCT:

“Though I believe that recurring business depressions can only be explained by the operation of our monetary institutions, I do not believe that it is possible to explain in this way every stagnation of business. This applies in particular to the kind of prolonged depression through which some European countries are passing today. It would be easy to demonstrate by the same type of analysis which I have used in the last two lectures that certain kinds of State action, by causing a shift in demand from producers’ goods to consumers' goods, may cause a continued shrinking of the capitalist structure of production, and therefore prolonged stagnation. This may be true of increased public expenditure in general or of particular forms of taxation or particular forms of public expenditure. In such cases, of course, no tampering with the monetary system can help. Only a radical revision of public policy can provide the remedy.” (Hayek 1935: 128).

BIBLIOGRAPHY
Hayek, F. A. von. 1931. Prices and Production. G. Routledge & Sons, Ltd, London.

Hayek, F. A. von. 1935. Prices and Production (2nd edn). Routledge and Kegan Paul.

Hayek’s Prices and Production (1935), Lecture III: A Summary

I summarise below Lecture III of Hayek’s Prices and Production (2nd edn.; 1935), the classic work where Hayek developed his version of the Austrian business cycle theory (ABCT). I use the second, revised edition of 1935 (the first edition was published in 1931).

Hayek has a long analysis of the prices of intermediate goods in different stages of production (Hayek 1935: 70–83).

If money supply is increased by banks and the rate of interest falls below the natural rate (Hayek 1935: 86; and Hayek specifically states that in equilibrium the rate of return on capital is equal to the interest rate [Hayek 1935: 73]) and credit is obtained by producers, then Hayek’s Austrian business cycle is initiated:

“Now the borrowers can only use the borrowed sums for buying producers’ goods, and will only be able to obtain such goods (assuming a state of equilibrium in which there are no unused resources) by outbidding the entrepreneurs who used them before. At first sight it might seem improbable that these borrowers who were only put in a position to start longer processes by the lower rate of interest should be able to outbid those entrepreneurs who found the use of those means of production profitable when the rate of interest was still higher. But when it is remembered that the fall in the rate will also change the relative profitableness of the different factors of production for the existing concerns, it will be seen to be quite natural that it should give a relative advantage to those concerns which use proportionately more capital. Such old concerns will now find it profitable to spend a part of what they previously spent on original means of production, on intermediate products produced by earlier stages of production, and in this way they will release some of the original means of production they used before. The rise in the prices of the original means of production is an additional inducement. Of course it might well be that the entrepreneurs in question would be in a better position to buy such goods even at the higher prices, since they have done business when the rate of interest was higher, though it must not be forgotten that they too will have to do business on a smaller margin. But the fact that certain producers’ goods have become dearer will make it profitable for them to replace these goods by others. In particular, the changed proportion between the prices of the original means of production and the rate of interest will make it profitable for them to spend part of what they have till now spent on original means of production on intermediate products or capital. They will, e.g., buy parts of their products, which they used to manufacture themselves, from another firm, and can now employ the labour thus dismissed in order to produce these parts on a large scale with the help of new machinery. In other words, those original means of production and non-specific producers’ goods which are required in the new stages of production are set free by the transition of the old concerns to more capitalistic methods which is caused by the increase in the prices of these goods. In the old concerns (as we may conveniently, but not quite accurately, call the processes of production which were in operation before the new money was injected) a transition to more capitalistic methods will take place; but in all probability it will take place without any change in their total resources: they will invest less in original means of production and more in intermediate products.

Now, contrary to what we have found to be the case when similar processes are initiated by the investment of new savings, this application of the original means of production and non-specific intermediate products to longer processes of production will be effected without any preceding reduction of consumption. Indeed, for a time, consumption may even go on at an unchanged rate after the more roundabout processes have actually started, because the goods which have already advanced to the lower stages of production, being of a highly specific character, will continue to come forward for some little time. But this cannot go on. When the reduced output from the stages of production, from which producers’ goods have been withdrawn for use in higher stages, has matured into consumers’ goods, a scarcity of consumers’ goods will make itself felt, and the prices of those goods will rise. Had saving preceded the change to methods of production of longer duration, a reserve of consumers’ goods would have been accumulated in the form of increased stocks, which could now be sold at unreduced prices, and would thus serve to bridge the interval of time between the moment when the last products of the old shorter process come on to the market and the moment when the first products of the new longer processes are ready. But as things are, for some time, society as a whole will have to put up with an involuntary reduction of consumption.” (Hayek 1935: 86–88).

This is a curious aspect of Hayek’s theory: according to Hayekian ABCT, there will be, as investment in higher stages of production proceeds, a “scarcity of consumers’ goods” and “the prices of those goods will rise.” It is not clear whether this means an actual fall in real consumption, or merely excess demand in relation to supply and rising prices.

As an aside, in Mises’ version of the ABCT there does appear to be a contraction of consumer goods output in the later stages of the boom:

“The situation is as follows: despite the fact that there has been no increase of intermediate products and there is no possibility of lengthening the average period of production, a rate of interest is established in the loan market which corresponds to a longer period of production; and so, although it is in the last resort inadmissible and impracticable, a lengthening of the period of production promises for the time to be profitable. But there cannot be the slightest doubt as to where this will lead. A time must necessarily come when the means of subsistence available for consumption are all used up although the capital goods employed in production have not yet been transformed into consumption goods. This time must come all the more quickly inasmuch as the fall in the rate of interest weakens the motive for saving and so slows up the rate of accumulation of capital. The means of subsistence will prove insufficient to maintain the labourers during the whole period of the process of production that has been entered upon. Since production and consumption are continuous, so that every day new processes of production are started upon and others completed, this situation does not imperil human existence by suddenly manifesting itself as a complete lack of consumption goods; it is merely expressed in a reduction of the quantity of goods available for consumption and a consequent restriction of consumption. The market prices of consumption goods rise and those of production goods fall.” (Mises 2009 [1953]: 362–363).

To return to Hayek’s version of ABCT, he continues:

“But this necessity will be resisted. It is highly improbable that individuals should put up with an unforeseen retrenchment of their real income without making an attempt to overcome it by spending more money on consumption. It comes at the very moment when a great many entrepreneurs know themselves to be in command—at least nominally—of greater resources and expect greater profits. At the same time incomes of wage earners will be rising in consequence of the increased amount of money available for investment by entrepreneurs. There can be little doubt that in the face of rising prices of consumers’ goods these increases will be spent on such goods and so contribute to drive up their prices even faster. These decisions will not change the amount of consumers’ goods immediately available, though it may change their distribution between individuals. But—and this is the fundamental point—it will mean a new and reversed change of the proportion between the demand for consumers’ goods and the demand for producers' goods in favour of the former. The prices of consumers’ goods will therefore rise relatively to the prices of producers’ goods. And this rise of the prices of consumers’ goods will be the more marked because it is the consequence not only of an increased demand for consumers’ goods but an increase in the demand as measured in money. All this must mean a return to shorter or less roundabout methods of production if the increase in the demand for consumers' goods is not compensated by a further proportional injection of money by new bank loans granted to producers. And at first this is probable. The rise of the prices of consumers’ goods will offer prospects of temporary extra profits to entrepreneurs. They will be the more ready to borrow at the prevailing rate of interest. And, so long as the banks go on progressively increasing their loans it will therefore, be possible to continue the prolonged methods of production or perhaps even to extend them still further. But for obvious reasons the banks cannot continue indefinitely to extend credits; and even if they could, the other effects of a rapid and continuous rise of prices would, after a while, make it necessary to stop this process of inflation.” (Hayek 1935: 88–90).

So as the wages of workers are bid up, the process by which consumer goods’ prices rise is accelerated. So it seems that a crisis of inflation marks the shift to the “bust” (Hayek 1934 is an earlier discussion of how the boom turns into a bust).

We can trace the steps by which the boom turns into the bust:

(1) when the banks cease to advance new loans and the money rate of interest rises, the demand for producers’ goods falls, but demand for consumers goods will continue to increase for some time, as they “lag somewhat behind the additional expenditure on investment which causes the increase of money incomes” (Hayek 1935: 90–91);

(2) producers will want to shift back to producing consumer goods at the lower stages of production, but that process causes the bust:

“Very soon the relative rise of the prices of the original factors and the more mobile intermediate products will make the longer processes unprofitable. The first effect on these processes will be that the producers’ goods of a more specific character, which have become relatively abundant by reason of the withdrawal of the complementary non-specific goods, will fall in price. The fall of the prices of these goods will make their production unprofitable; it will in consequence be discontinued. Although goods in later stages of production will generally be of a highly specific character, it may still pay to employ original factors to complete those that are nearly finished. But the fall in the price of intermediate products will be cumulative; and this will mean a fairly sudden stoppage of work in at least all the earlier stages of the longer processes.

But while the non-specific goods, in particular the services of workmen employed in those earlier stages, have thus been thrown out of use because their amount has proved insufficient and their prices too high for the profitable carrying through of the long processes of production, it is by no means certain that all those which can no longer be used in the old processes can immediately be absorbed in the short processes which are being expanded. Quite the contrary; the shorter processes will have to be started at the very beginning and will only gradually absorb all the available producers’ goods as the product progresses towards consumption and as the necessary intermediate products come forward. So that, while, in the longer processes, productive operations cease almost as soon as the change in relative prices of specific and non-specific goods in favour of the latter and the rise of the rate of interest make them unprofitable, the released goods will find new employment only as the new shorter processes are approaching completion. Moreover, the final adaptation will be further retarded by initial uncertainty as regards the methods of production which will ultimately prove profitable once the temporary scarcity of consumers’ goods has disappeared. Entrepreneurs, quite rightly, will hesitate to make investments suited to this overshortened process, i.e., investments which would enable them to produce with relatively little capital and a relatively great quantity of the original means of production.” (Hayek 1935: 92–93).

So now the process shifts to the bust.

(3) Hayek sees the explanation of unused resources as the great achievement of his ABCT:

“Here then we have at last reached an explanation of how it comes about at certain times that some of the existing resources cannot be used, and how, in such circumstances, it is impossible to sell them at all—or, in the case of durable goods, only to sell them at very great loss. To provide an answer to this problem has always seemed to me to be the central task of any theory of industrial fluctuations; and, though at the outset I refused to base my investigation on the assumption that unused resources exist, now that I have presented a tentative explanation of this phenomenon, it seems worth while, rather than spending time filling up the picture of the cycle by elaborating the process of recovery, to devote the rest of this lecture to further discussion of certain important aspects of this problem. Now that we have accounted for the existence of unused resources, we may even go so far as to assume that their existence to a greater or lesser extent is the regular state of affairs save during a boom. And, if we do this, it is imperative to supplement our earlier investigation of the effects of a change in the amount of money in circulation on production, by applying our theory to such a situation. And this extension of our analysis is the more necessary since the existence of unused resources has very often been considered as the only fact which at all justifies an expansion of bank credit.” (Hayek 1935: 97–98).

At this point Hayek now considers situations where unused resources exist “to a greater or lesser extent” as a “regular state of affairs save during a boom”:

“If the foregoing analysis is correct, it should be fairly clear that the granting of credit to consumers, which has recently been so strongly advocated as a cure for depression, would in fact have quite the contrary effect; a relative increase of the demand for consumers’ goods could only make matters worse. Matters are not quite so simple so far as the effects of credits granted for productive purposes are concerned. In theory it is at least possible that, during the acute stage of the crisis when the capitalistic structure of production tends to shrink more than will ultimately prove necessary, an expansion of producers’ credits might have a wholesome effect. But this could only be the case if the quantity were so regulated as exactly to compensate for the initial, excessive rise of the relative prices of consumers’ goods, and if arrangements could be made to withdraw the additional credits as these prices fall and the proportion between the supply of consumers’ goods and the supply of intermediate products adapts itself to the proportion between the demand for these goods. And even these credits would do more harm than good if they made roundabout processes seem profitable which, even after the acute crisis had subsided, could not be kept up without the help of additional credits. Frankly, I do not see how the banks can ever be in a position to keep credit within these limits.

And, if we pass from the moment of actual crisis to the situation in the following depression, it is still more difficult to see what lasting good effects can come from credit-expansion. The thing which is needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production to the proportion between the demand for Consumers’ goods and the demand for producers’ goods as determined by voluntary saving and spending. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand, it must mean that part of the available resources is again led into a wrong direction and a definite and lasting adjustment is again postponed. And, even if the absorption of the unemployed resources were to be quickened in this way, it would only mean that the seed would already be sown for new disturbances and new crises. The only way permanently to ‘mobilise’ all available resources is, therefore, not to use artificial stimulants—whether during a crisis or thereafter—but to leave it to time to effect a permanent cure by the slow process of adapting the structure of production to the means available for capital purposes.

(10) And so, at the end of our analysis, we arrive at results which only confirm the old truth that we may perhaps prevent a crisis by checking expansion in time, but that we can do nothing to get out of it before its natural end, once it has come.” (Hayek 1935: 97–99).

It is here that Hayek earned his reputation as a liquidationist: for he says clearly that “we can do nothing to get out of it before its natural end.”

BIBLIOGRAPHY
Hayek, F. A. von. 1931. Prices and Production. G. Routledge & Sons, Ltd, London.

Hayek, F. A. von. 1934. “Capital and Industrial Fluctuations,” Econometrica 2.2: 152–167.

Hayek, F. A. von. 1935. Prices and Production (2nd edn). Routledge and Kegan Paul.

Mises, L. von. 2009 [1953]. The Theory of Money and Credit (enlarged, new edn). Ludwig von Mises Institute, Auburn, Ala.

Hayek’s Prices and Production (1935), Lecture II: A Summary

I summarise below Lecture II of Hayek’s Prices and Production (2nd edn.; 1935), the classic work where Hayek developed his version of the Austrian business cycle theory (ABCT). I use the second, revised edition of 1935 (the first edition was published in 1931).

Hayek commits himself to a static Walrasian general equilibrium model early in his Lecture II:

“…it is my conviction that if we want to explain economic phenomena at all, we have no means available but to build on the foundations given by the concept of a tendency towards an equilibrium. For it is this concept alone which permits us to explain fundamental phenomena like the determination of prices or incomes, an understanding of which is essential to any explanation of fluctuation of production. If we are to proceed systematically, therefore, we must start with a situation which is already sufficiently explained by the general body of economic theory. And the only situation which satisfies this criterion is the situation in which all available resources are employed. The existence of unused resources must be one of the main objects of our explanation.

(4) To start from the assumption of equilibrium has a further advantage. For in this way we are compelled to pay more attention to causes of changes in the industrial output whose importance might otherwise be underestimated. I refer to changes in the methods of using the existing resources. Changes in the direction given to the existing productive forces are not only the main cause of fluctuations of the output of individual industries; the output of industry as a whole may also be increased or decreased to an enormous extent by changes in the use made of existing resources. Here we have the third of the contemporary explanations of fluctuations which I referred to at the beginning of the lecture. What I have here in mind are not changes in the methods of production made possible by the progress of technical knowledge, but the increase of output made possible by a transition to more capitalistic methods of production, or, what is the same thing, by organising production so that, at any given, moment, the available resources are employed for the satisfaction of the needs of a future more distant than before. It is to this effect of a transition to more or less ‘roundabout’ methods of production that I wish particularly to direct your attention. For, in my opinion, it is only by an analysis of this phenomenon that in the end we can show how a situation can be created in which it is temporarily impossible to employ all available resources.” (Hayek 1935: 34–36).

Hayek is also concerned with the structure of production: that is, changes which involve a longer as opposed to a shorter period of production and a hence a longer period of time before final consumer goods output is produced (Hayek 1935: 38).

Hayek has the following famous diagram illustrating the structure of production, as below.

Hayek explains this diagram as follows:

… “I find it convenient to represent the successive applications of the original means of production which are needed to bring forth the output of consumers’ goods accruing at any moment of time, by the hypotenuse of a right-angled triangle, such as the triangle in Fig. I. The value of these original means of production is expressed by the horizontal projection of the hypotenuse, while the vertical dimension, measured in arbitrary periods from the top to the bottom, expresses the progress of time, so that the inclination of the line representing the amount of original means of production used means that these original means of production are expended continuously during the whole process of production. The bottom of the triangle represents the value of the current output of consumers’ goods. The area of the triangle thus shows the totality of the successive stages through which the several units of original means of production pass before they become ripe for consumption. It also shows the total amount of intermediate products which must exist at any moment of time in order to secure a continuous output of consumers’ goods. For this reason we may conceive of this diagram not only as representing the successive stages of the production of the output of any given moment of time, but also as representing the processes of production going on simultaneously in a stationary society.” (Hayek 1935: 38–40).

As time increases between the use of the original means of production and the actual production of final consumer goods output, production becomes “more capitalistic” (Hayek 1935: 42).

The crucial problem for Hayek is: how does an economy transition from lower to much higher “capitalistic” methods of production? (Hayek 1935: 49).

The answer:

“… a transition to more (or less) capitalistic methods of production will take place if the total demand for producers’ goods (expressed in money) increases (or decreases) relatively to the demand for consumers’ goods. This may come about in one of two ways: either as a result of changes in the volume of voluntary saving (or its opposite), or as a result of a change in the quantity of money which alters the funds at the disposal of the entrepreneurs for the purchase of producers’ goods.” (Hayek 1935: 50).

What underlies this reasoning are the following assumptions:

(1) A Wicksellian loanable funds theory, where money interest rates are determined by time preference and are a reliable and effective indicator of inter-temporal consumption plans;

(2) the assumption that investment is a straightforward function of money interest rates, and

(3) a situation of general equilibrium in which no unused resources are available.

BIBLIOGRAPHY
Hayek, F. A. von. 1931. Prices and Production. G. Routledge & Sons, Ltd, London.

Hayek, F. A. von. 1935. Prices and Production (2nd edn). Routledge and Kegan Paul.

Hayek’s Prices and Production (1935), Lecture I: A Summary

In what follows, I summarise Lecture I of Hayek’s Prices and Production (2nd edn.; 1935), the classic work where Hayek developed his version of the Austrian business cycle theory (ABCT). I use the second, revised edition of 1935 (the first edition was published in 1931).

Hayek notes that by the 1930s it was widely accepted that monetary influences can play a great role in the “volume and direction of production” (Hayek 1935: 1).

Hayek devotes much of Lecture I to a review of the history of monetary theory. The first major stage of monetary theory was the development of the quantity theory.

However, Hayek criticised the quantity theory for neglecting the way in which money supply changes can cause changes in relative prices (Hayek 1935: 3–6). Hayek concludes that money is not neutral in its effects (Hayek 1935: 7).

The “second stage” in the history of monetary theory was the realisation that the quantity theory is wrong to assume that money supply changes merely affect the general price level in a uniform and proportional manner (Hayek 1935: 8). Locke, Montanari and, above all, Richard Cantillon realised this (Hayek 1935: 8). Hayek sketches the mechanism we now call Cantillon effects (Hayek 1935: 9–10):

“… [sc. Cantillon] attempts to show ‘by what path and in what proportion the increase of money raises the price of things’. Starting from the assumption of the discovery of new gold or silver mines, he proceeds to show how this additional supply of the precious metals first increases the incomes of all persons connected with their production, how the increase of the expenditure of these persons next increases the prices of things which they buy in increased quantities, how the rise in the prices of these goods increases the incomes of the sellers of these goods, how they, in their turn, increase their expenditure, and so on. He concludes that only those persons are benefited by the increase of money whose incomes rise early, while to persons whose incomes rise later the increase of the quantity of money is harmful.” (Hayek 1935: 8–9).

The “third stage” in the development of monetary theory was when economists examined how money supply increases affect the rate of interest, and through this the demand for capital goods and consumer goods (Hayek 1935: 11–12).

Hayek traces these ideas through the 19th century British economists and writers, and lists the following:

(1) Henry Thornton’s An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802), p. 287.

(2) Lord King’s Thoughts on the Effects of the Bank Restriction (London, 1803), p. 20.

(3) John Leslie Foster’s An Essay on the Principles of Commercial Exchanges (London, 1804), p. 113.

(4) David Ricardo’s The High Price of Bullion: A Proof of the Depreciation of Bank Notes (2nd edn.; London, 1810), p. 47, and On the Principles of Political Economy and Taxation (3rd edn.; London, 1821), p. 349–350.

(5) the “Report of the Committee on Gold Bullion” (London, 1810), p. 56.

(6) Thomas Joplin’s Outlines of a System of Political Economy (London, 1823), pp. 37–38, and An Analysis and History of the Currency Question (London, 1832).

(7) Thomas Tooke’s An Inquiry into the Currency Principle (London, 1844), p. 77, and Considerations of the State of the Currency (London, 1826), p. 22.

(8) Nassau William Senior’s Biographical Sketches (London, 1863).

(9) John Stuart Mill’s Principles of Political Economy: With Some of their Applications to Social Philosophy (6th edn.; London, 1865).

These authors presented monetary theories that were precursors to Knut Wicksell’s monetary equilibrium theory, with a natural rate of interest set by the profits on real capital and a money rate of interest that can diverge from the natural rate.

The “fourth stage” of monetary theory seen by Hayek as the antecedent to the ABCT was that linking money supply and interest rate changes to the production of capital goods (Hayek 1935: 18). The authors cited by Hayek who developed the idea of “forced saving” in relation to capital goods investment are as follows:

(1) Jeremy Bentham’s Manual of Political Economy (written in 1804 but only published in 1843).

(2) Thomas Robert Malthus’ “Depreciation of Paper Currency,” Edinburgh Review 17.34 (1811): 339–372, at p. 363.

(3) John Stuart Mill’s “On Profits and Interest” and Principles of Political Economy (6th edn.; London, 1865).

Leon Walras probably rediscovered the “forced saving” doctrine in 1879, and from him it passed to Wicksell (Hayek 1935: 22).

But it was Wicksell who combined the different strands of monetary theory into one synthesis (Hayek 1935: 23).

Hayek then summarised Wicksell’s monetary equilibrium theory as follows:

“Put concisely, Wicksell’s theory is as follows: If it were not for monetary disturbances, the rate of interest would be determined so as to equalize the demand for and the supply of savings. This equilibrium rate, as I prefer to call it, he christens the natural rate of interest. In a money economy, the actual or money rate of interest (“Geldzins”) may differ from the equilibrium or natural rate, because the demand for and the supply of capital do not meet in their natural form but in the form of money, the quantity of which available for capital purposes may be arbitrarily changed by the banks.

Now, so long as the money rate of interest coincides with the equilibrium rate, the rate of interest remains “neutral” in its effects on the prices of goods, tending neither to raise nor to lower them. When the banks, however, lower the money rate of interest below the equilibrium rate, which they can do by lending more than has been entrusted to them, i.e., by adding to the circulation, this must tend to raise prices; if they raise the money rate above the equilibrium rate—a case of less practical importance—they exert a depressing influence on prices. From this correct statement, however, which does not imply that the price level would remain unchanged if the money rate corresponds to the equilibrium rate, but only that, in such conditions, there are no monetary causes tending to produce a change in the price level, Wicksell jumps to the conclusion that, so long as the two rates agree, the price level must always remain steady. There will be more to say about this later. For the moment, it is worth observing a further development of the theory. The rise of the price level which is supposed to be the necessary effect of the money rate remaining below the equilibrium rate, is in the first instance brought about by the entrepreneurs spending on production the increased amount of money loaned by the banks. This process, as Malthus had already shown, involves what Wicksell now called enforced or compulsory saving. That is all I need to say here in explanation of the Wicksellian theory.” (Hayek 1935: 23–25).

Mises had already adopted Wicksell’s monetary theory and developed the first form of the ABCT (Hayek 1935: 25), and Hayek’s own version in Prices and Production was a development of Mises’.

Hayek departs from Wicksell’s monetary theory on a number of points:

(1) Hayek thinks that the banks need to keep the amount of money in circulation unchanged to secure a stable price level, and

(2) the amount of money in circulation has to be changed as the volume of production increases or decreases (Hayek 1935: 27).

But Hayek thinks that the banks cannot keep the demand for real capital in line with the supply of savings and the price level stable at the same time, except in a stationary equilibrium state (Hayek 1935: 27). In times of expansion of production, even when the money rate of interest is equal to the natural rate, there would be a falling price level (Hayek 1935: 27):

“The banks could either keep the demand for real capital within the limits set by the supply of savings, or keep the price level steady; but they cannot perform both functions at once. Save in a society in which there were no additions to the supply of savings, i.e., a stationary society, to keep the money rate of interest at the level of the equilibrium rate would mean that in times of expansion of production the price level would fall. To keep the general price level steady would mean, in similar circumstances, that the loan rate of interest would have to be lowered below the equilibrium rate. The consequences would be what they always are when the rate of investment exceeds the rate of saving.” (Hayek 1935: 27–28).

Hayek also repudiates the idea of a general price level as a useful economic concept (Hayek 1935: 29–30).

In place of the general value of money, Hayek substitutes the crucial concept of how money influences the relative values of goods (Hayek 1935: 31). If money leaves relative values of goods’ prices unchanged, then money is “neutral” (Hayek 1935: 31).

BIBLIOGRAPHY
Foster, John Leslie. 1804. An Essay on the Principles of Commercial Exchanges, and more particularly of the Exchange between Great Britain and Ireland: With an Inquiry into the Practical Effects of the Bank Restrictions. J. Hatchard, London.

Hayek, F. A. von. 1931. Prices and Production. G. Routledge & Sons, Ltd, London.

Hayek, F. A. von. 1935. Prices and Production (2nd edn). Routledge and Kegan Paul.

Joplin, Thomas. 1823. Outlines of a System of Political Economy: written with a View to Prove to Government and the Country, that the Cause of the Present Agricultural Distress is Entirely Artificial: and to suggest a Plan for the Management of the Currency. Baldwin, Cradock, and Joy, London.

Joplin, Thomas. 1832. An Analysis and History of the Currency Question: Together with an Account of the Origin and Growth of Joint Stock Banking in England: Comprised in a Brief Memoir of the Writer’s Connexion with these Subjects. James Ridgway, London.

Malthus, Thomas Robert. 1811. “Depreciation of Paper Currency,” Edinburgh Review 17.34: 339–372.

Mill, John Stuart. 1865. Principles of Political Economy: With Some of their Applications to Social Philosophy (6th edn.). Longmans Green, London.

Report from the Committee of Secrecy on the Bank of England Charter: With the Minutes of Evidence, Appendix and Index, J. & L. G. Hansard & sons, London, 1832.

Report, Together with Minutes of Evidence, and Accounts from the Select Committee on the High Price of Gold Bullion: Ordered, by the House of Commons, to be Printed, 8 June 1810 (Report of the Committee on Gold Bullion, 1810), J. Johnson and J. Ridgway, London, 1810.

Ricardo, David. 1810. The High Price of Bullion: A Proof of the Depreciation of Bank Notes (2nd edn.). John Murray, London.

Ricardo, David. 1821. On the Principles of Political Economy and Taxation (3rd edn.). John Murray, London.

Senior, Nassau William. 1863. Biographical Sketches. Longman, Green, Longman, Roberts, & Green, London.

Thornton, Henry. 1802. An Enquiry into the Nature and Effects of the Paper Credit of Great Britain. J. Hatchard, London.

Tooke, Thomas. 1826. Considerations of the State of the Currency. John Murray, London.

Tooke, Thomas. 1844. An Inquiry into the Currency Principle: The Connection of the Currency with Prices, and the Expediency of a Separation of Issue from Banking. Longman, Brown, Green, and Longmans, London.

Post Keynesian Labour Market Theory: A Summary

The Post Keynesian view on labour markets is opposed to that of neoclassical economics. A summary of Post Keynesian labour market theory from Lavoie (1992) follows.

Post Keynesian economics holds that labour markets are not necessarily well behaved, that the wage rate is not an ordinary “price”, and that wages cuts can have perverse effects on economic activity contrary to neoclassical theory (Lavoie 1992: 217).

Wages are not, general speaking, set by reference to marginal product of labour, but wage rate determination is affected by notions of fairness, justice and social norms, and these factors can affect all attributes of labour from the real/nominal wage to productivity, working week, job safety, security and so on (Lavoie 1992: 218).

At the aggregate level, there is no necessary and consistent relationship between the real wage and demand for labour (Lavoie 1992: 217).

Even the neoclassical view that work necessarily carries disutility is untrue: work per se can be rewarding and bring satisfaction (Lavoie 1992: 218).

Lavoie (1992: 218) points to the dual labour market hypothesis, which is that most advanced economies have two sub-labour markets, as follows:

(1) the “core” economy labour market
Here wages and productivity are high, costs of labour training are high, and there is a greater degree of unionisation.

(2) the “peripheral” labour market
Here wages are generally low, little training is required, and turnover is high (Lavoie 1992: 218–219).

The administered pricing/mark-up pricing sector of an economy strongly corresponds to the “core” economy, though imperfectly.

A strong general characteristic of most households is that they wish to maintain their standard of living, and that they face fixed nominal contractual obligations like debt, and hence the need to maintain income levels (Lavoie 1992: 222). This, though amongst other reasons too, translates into a strong opposition to nominal wage cuts.

Even labour supply often depends on a perceived target wage rate and past standards of living (Lavoie 1992: 222–223), not necessarily on movements of the real wage rate.

The demand for labour is mostly driven by demand for output, and hence aggregate demand drives employment levels.

BIBLIOGRAPHY
Lavoie, Marc. 1992. Foundations of Post-Keynesian Economic Analysis. Edward Elgar Publishing, Aldershot, UK.

The General Theory, Chapter 19: Changes in Money-Wages

Chapter 19 of The General Theory is a crucial one: it discusses the consequences of nominal wages cuts in modern market economies.

Keynes begins by pointing out that neoclassical economics (which he called the “Classical” theory) assumes that a major reason why market economies are supposed to self-adjust is via flexible wages (and, by implication, prices). When wages are rigid, this is (allegedly) the cause of serious maladjustment in neoclassical theory (Keynes 1964 [1936]: 257).

Keynes accepted that a “reduction in money-wages is quite capable in certain circumstances of affording a stimulus to output, as the classical theory supposes” (Keynes 1964 [1936]: 257), but there were many reasons why it would not generally do so.

Keynes also emphasised the need to distinguish the real wage from the nominal wage (or “money-wage”) (Keynes 1964 [1936]: 259).

Keynes analysed the effects of reductions in nominal wages in the following way:

(1) a reduction in nominal wages may reduce prices, but if the price falls are uneven, it will redistribute real income from wage-earners to other classes of society, such as producers and rentiers (the latter of whom often have fixed incomes) (Keynes 1964 [1936]: 262). But this is likely to reduce the aggregate level of consumption (or propensity to consume), so that the macroeconomic effects will actually be harmful (Keynes 1964 [1936]: 262).

(2) if the reduction in nominal wages affects industries that export products, then a reduction in money wages might stimulate demand for a nation’s exports and hence its domestic investment (Keynes 1964 [1936]: 262–263). Keynes noted that the UK of his day was an export-led economy (as compared with the United States), and that this accounted for the popularity of the belief that cutting money-wages would increase employment in Great Britain (Keynes 1964 [1936]: 263).

(3) but in an open economy, a reduction in money wages may increase the favourable balance of trade but worsen the terms of trade (Keynes 1964 [1936]: 263).

(4) If a reduction in money wages occurs but with expectations of further wage rises in the future, then this might be favourable to consumption and investment (Keynes 1964 [1936]: 263).

But, if a reduction in money wages leads to expectations of further wage cuts in the future, then it may well be counterproductive as it may lead to deferment of both investment and consumption (Keynes 1964 [1936]: 263).

(5) If both a reduction in wages and some fall in prices occur, and lead to a lower liquidity preference, then this will reduce the rate of interest, and prove favourable to investment.

But if, at the same time, there is an expectation of further wage and price increases in the future, then demand for long-term loans may not be as great as demand for short term loans (Keynes 1964 [1936]: 263), and if wage cuts cause loss of confidence and discontent, the increase in liquidity preference might more than offset the original reduction in the latter (Keynes 1964 [1936]: 264).

(6) A reduction of wages simply within one particular industry will be advantageous to the capitalist owners and/or managers of that industry, and a general reduction in wages throughout an economy might produce an optimistic mood amongst entrepreneurs in general, but labour troubles are likely to complicate matters badly:

“On the other hand, if the workers make the same mistake as their employers about the effects of a general reduction, labour troubles may offset this favourable factor; apart from which, since there is, as a rule, no means of securing a simultaneous and equal reduction of money-wages in all industries, it is in the interest of all workers to resist a reduction in their own particular case. In fact, a movement by employers to revise money-wage bargains downward will be much more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices.” (Keynes 1964 [1936]: 264).

(7) And, crucially, Keynes pointed to the disastrous effects of debt deflation:

“On the other hand, the depressing influence on entrepreneurs of their greater burden of debt may partly offset any cheerful reactions from the reduction of wages. Indeed if the fall of wages and prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, — with severely adverse effects on investment. Moreover the effect of the lower price-level on the real burden of the National Debt and hence on taxation is likely to prove very adverse to business confidence.” (Keynes 1964 [1936]: 264).

To this Keynes could have added that private household debt will have much the same disastrous effects if wage and price deflation proceeds far enough.

Keynes, then, pointed to the negative distributional and other effects of wage reductions, and contended that only (4) or (5) gave much hope of inducing favourable results from nominal wage cuts.

But, with respect to (4), in order to prevent the expectation of further nominal wage cuts, a wage reduction would have to be deep and wide enough throughout an economy and limited to a single occurrence:

“The contingency, which is favourable to an increase in the marginal efficiency of capital, is that in which money-wages are believed to have touched bottom, so that further changes are expected to be in the upward direction. The most unfavourable contingency is that in which money-wages are slowly sagging downwards and each reduction in wages serves to diminish confidence in the prospective maintenance of wages. When we enter on a period of weakening effective demand, a sudden large reduction of money-wages to a level so low that no one believes in its indefinite continuance would be the event most favourable to a strengthening of effective demand. But this could only be accomplished by administrative decree and is scarcely practical politics under a system of free wage-bargaining.” (Keynes 1964 [1936]: 265).

Next Keynes notes that market equilibration in neoclassical theory depends on effective wage and price adjustment maintaining consumption and smoothing out changes in the demand to hold money:

“It is, therefore, on the effect of a falling wage- and price-level on the demand for money that those who believe in the self-adjusting quality of the economic system must rest the weight of their argument; though I am not aware that they have done so. If the quantity of money is itself a function of the wage- and price-level, there is indeed, nothing to hope in this direction. But if the quantity of money is virtually fixed, it is evident that its quantity in terms of wage-units can be indefinitely increased by a sufficient reduction in money-wages; and that its quantity in proportion to incomes generally can be largely increased, the limit to this increase depending on the proportion of wage-cost to marginal prime cost and on the response of other elements of marginal prime cost to the falling wage-unit.” (Keynes 1964 [1936]: 266).

In effect, Keynes is saying that the neoclassical belief in market equilibration via wage reductions depends on the “real balances” effect (Hayes 2006: 177) (and note how Keynes assumes an exogenous money supply here too).

Keynes continues by noting that, in some respects, a cut in nominal wages is effectively equivalent to expansionary monetary policy (Keynes 1964 [1936]: 266; Hayes 2006: 178). But Keynes argues that the clear advantages of increasing the money supply over reductions in nominal wages make the latter an absurd policy.

Keynes sketches his argument for this view in the following way:

(1) It is paradoxically only in a fully socialist economy that wage policy can be done uniformly and effectively by administrative decree. In a market economy, it is unrealistic to think that there could be “uniform wage reductions for every class of labour” (Keynes 1964 [1936]: 267):

“The result [sc. uniform wage reductions] can only be brought about by a series of gradual, irregular changes, justifiable on no criterion of social justice or economic expediency, and probably completed only after wasteful and disastrous struggles, where those in the weakest bargaining position will suffer relatively to the rest. A change in the quantity of money, on the other hand, is already within the power of most governments by open-market policy or analogous measures. Having regard to human nature and our institutions, it can only be a foolish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter. Moreover, other things being equal, a method which it is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable.” (Keynes 1964 [1936]: 267–268).

(2) Since certain classes of people such as rentiers have fixed incomes, a relatively rigid wage system is fairer:

“Thus the greatest practicable fairness will be maintained between labour and the factors whose remuneration is contractually fixed in terms of money, in particular the rentier class and persons with fixed salaries on the permanent establishment of a firm, an institution or the State. If important classes are to have their remuneration fixed in terms of money in any case, social justice and social expediency are best served if the remunerations of all factors are somewhat inflexible in terms of money. Having regard to the large groups of incomes which are comparatively inflexible in terms of money, it can only be an unjust person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages from the former which are not obtainable from the latter.” (Keynes 1964 [1936]: 268).

(3) Above all, money supply growth rather than wage cuts will overcome the dangers of debt deflation:

“The method of increasing the quantity of money in terms of wage-units by decreasing the wage-unit increases proportionately the burden of debt; whereas the method of producing the same result by increasing the quantity of money whilst leaving the wage unit unchanged has the opposite effect. Having regard to the excessive burden of many types of debt, it can only be an inexperienced person who would prefer the former.” (Keynes 1964 [1936]: 268).

(4) Finally, if a fall in interest rates is brought about by falling nominal wages, this can, as Keynes already noted, cause deferment of investment (Keynes 1964 [1936]: 269).

Furthermore, Keynes argued, gradual reductions in nominal money wages might have the perverse effect of actually increasing real wages (Keynes 1964 [1936]: 269).

Keynes’s conclusion, then, was as follows:

“In the light of these considerations I am now of the opinion that the maintenance of a stable general level of money-wages is, on a balance of considerations, the most advisable policy for a closed system; whilst the same conclusion will hold good for an open system, provided that equilibrium with the rest of the world can be secured by means of fluctuating exchanges. There are advantages in some degree of flexibility in the wages of particular industries so as to expedite transfers from those which are relatively declining to those which are relatively expanding. But the money-wage level as a whole should be maintained as stable as possible, at any rate in the short period.

This policy will result in a fair degree of stability in the price-level; — greater stability, at least, than with a flexible wage policy. Apart from ‘administered’ or monopoly prices, the price-level will only change in the short period in response to the extent that changes in the volume of employment affect marginal prime costs; whilst in the long period they will only change in response to changes in the cost of production due to new technique and new or increased equipment.” (Keynes 1964 [1936]: 270–271).

As an aside, I note here how Keynes seems to have assumed that “administered or monopoly prices” were not very significant. And that leads me into my last point.

What is especially interesting about Keynes’s analysis is this: it concedes points to neoclassical economics – such as the idea of exogenous money, prices determined by marginal cost, and relatively flexible but uneven price movements – that Keynes did not need to concede, but still Keynes shows that the neoclassical theory is deficient.

BIBLIOGRAPHY
Hayes, Mark. 2006. The Economics of Keynes: A New Guide to The General Theory. Edward Elgar, Cheltenham.

Keynes, J. M. 1964 [1936]. The General Theory of Employment, Interest, and Money. Harvest/HBJ Book, New York and London.